Supply Chain

How Low Can They Go?

A new mathematical model aims to infer the best price a supplier can offer while still making a profit.
Alix StuartNovember 1, 2007

Wonder whether your suppliers are truly giving you a good deal? Two professors who study online reverse auctions (in which buyers solicit bids and award their business to the low bidder) have devised a mathematical model that can assess whether a bid truly represents a seller’s best price.

Described in a working paper by Sandy Jap, professor at Emory University’s Goizueta Business School, and Prasad Naik, professor at the University of California Davis Graduate School of Management, the model — dubbed BidAnalyzer — aims to infer a supplier’s optimal bid; that is, the lowest price the supplier can offer while still making a profit. BidAnalyzer can begin to make such judgments with as few as three bids per supplier, although accuracy improves with more bids and cost-structure data.

In early tests, when the model indicated a supplier had given its best price, the chief procurement officer couldn’t gain anything more in post-auction negotiations; in a case where the model suggested that the supplier was holding back, the CPO won a 30 percent price reduction post-auction. Jap and Naik hope to build software based on their model.

“If it worked, it would be valuable,” says Jim Haining, contracts manager at the University Medical Center of Southern Nevada, in part because suppliers often “game” E auctions by basing their prices on competitors’ bids rather than their own cost structures.

Even sellers see an upside. Says Mark Ellis, CFO of giftware maker Michael C. Fina: “Sometimes when we lose, we question whether a bid might be too low, with companies underbidding to win the business.”